Risk equalization

Risk equalization is a way of equalizing the risk profiles of insurance members to avoid loading premiums on the insured to some predetermined extent.

In health insurance, it enables private health insurance to operate in some countries to be offered at a common rate for all even though insurers are not allowed by law to reject clients or impose special conditions for their health insurance. That is achieved by transfer payments by a risk equalization pool usually run by a neutral party, such as a government agency.

In unregulated competitive markets for individual health insurance, risk-rated premiums are observed to differ across subgroups of insured people, which are defined by rating factors such as age, gender, family size, geographic area (because costs of care may be higher or lower in some coverage areas than others) occupation, length of contract period, the level of deductible, health status at time of enrollment, health habits (smoking, drinking, exercising) and, via differentiated for multiyear no-claim, to prior costs.

Some nations that encourage private insurance for health care still seek to prevent insurers from engaging in risk minimizing actions to load the premiums of people with certain high-risk profiles, typically the elderly, the sick, and to some extent, women. Thus, financial transfers are needed in order to prohibit any discriminatory practices against these subgroups without increasing costs on insurers. This is done by arranging for a third party to organize a regulatory system of risk-adjusted premium subsidies.

The financial transfers are then channeled via a so-called Subsidy Fund. In European countries such as the Netherlands, Belgium, Germany, and Switzerland, the Subsidy Fund is run by a government agency, which assesses risks for individual policy holders. In all countries that apply risk-adjusted premium subsidies in their health insurance market, the sponsor organizes it in the form of risk equalization among health insurers: the risk-adjusted premium subsidies for the insured are channelled to the insurers. Then, the Subsidy Fund is called a Risk Equalization Fund (REF). An insurer receives a relatively large sum of subsidies by the REF if the risk profile of their members is relatively unhealthy and vice versa.

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Wikipedia